Chapter 30 Flashcards
(25 cards)
1
Q
- What are the possible responses to risk?
A
- Avoid transfer of risk
- Avoid financial coverage of risk (risk can be diversified away or it is too small)
- Reduce risk (mitigation)
- Transfer in full
- Retain in full
- Partly retain and partly transfer
2
Q
- What factors does one need to consider when applying a mitigation approach?
A
- Feasibility of implementation
- Cost vs benefit
- Impact on profit
- Impact on the NPV
- Secondary risks due to mitigation approach
- Control of secondary risks due to mitigation approach
- Impact on frequency and severity
3
Q
- What does the extent of risk transfer depend on (how much to transfer)?
A
- The existing resources to cover the risk event costs
- Cost of transferring the risk
- Probability of risk event occurring
- Willingness of third party to accept the risk
- Risk appetite
4
Q
- Which 3 forms does a treaty take form of?
A
- Obligatory – insurer obligated to cede, reinsurer obligated to accept
- Facultative – insurer chooses which risks to cede, reinsurer chooses which risks to accept
- Obligatory-facultative – insurer chooses which risks to cede, reinsurer is obligated to accept
5
Q
- What are the disadvantages of risk transfer?
A
- Risk
- Counterparty risk
- Systemic risk
6
Q
- What are the benefits of reinsurance?
A
- Reduces claims volatility
- Smooths profits
- Reduces capital requirements
- Increases potential for new business
- New business means more diversification
- Limits the large losses
- Can take on businesses of large risks
- Reduces risk of insolvency
- Access to expertise and data
- Reduces business risk (risk of inappropriate assumptions)
- Reduces operational risk (transfers some activities to reinsurer)
- Reduces new business strain (due to reduction of capital requirements)
7
Q
- What are the disadvantages of reinsurance?
A
- There is a cost to reinsurance and since the reinsurer needs to make a profit, the cost is higher than the financial loss of the event
- Credit risk
- Cover may be inappropriate
8
Q
- What are the types of reinsurance?
A
- Proportional
- Surplus
- Quota share
- Non-proportional - Excess of loss
o Catastrophe XL
o Risk XL
o Stop loss XL
o Aggregate XL
9
Q
- What are the types of proportional reinsurance?
A
Quota share – reinsurer pays a fixed percentage of each and every risk reinsured
Surplus reinsurance – percentage paid by reinsurer varies by risk. Percentage retained=(retention limit for each risk )/(EML for each risk)
10
Q
- What are the advantages of Quota Share
A
- Advantages of reinsurance
- Simple to administer
- May involve reciprocal business from the reinsurer
11
Q
- What are the disadvantages of Quota Share?…
A
- Disadvantages of reinsurance
- But cedes the same proportion of low variance and high variance risks and of small and large risks. – insurer may want to retain risks of lower volatility and transfer a larger chunk of high volatility risks
- It does not cap the cost of very large claims – insurer may still pay out a large claim
- Proportion doesn’t vary by risk
- Inflexible
12
Q
- What are the advantages of surplus reinsurance
A
- Flexible – solves a disadvantage of quota share reinsurance
13
Q
- What are the disadvantages of surplus reinsurance
A
- Complex to administer
- May forget to reinsure facultative (may want to add excess of loss to cover the remaining losses)
14
Q
- What are the types of non - proportional reinsurance?
A
- Catastrophe XL – covers risks defined as catastrophe events in the treaty and pays out any loss above a stated excess point
- Risk XL – covers individual risks and pays out any loss above a stated excess point
- Aggregate XL – covers aggregate risk (aggregated by peril, class, event) and pays out any loss above a stated excess point
- Stop loss – form of aggregate XL and pays out any aggregate loss over a specified period (maybe a year) that is above a stated excess point
15
Q
- What are the advantages of non-proportional reinsurance
A
Advantages of reinsurance
* Cedant can accept larger risks – since it caps large losses
* Reduce claims+ inflation
* Reduce risk of insolvency
* Protects the cedant against individual or aggregate large claims
16
Q
- What are the disadvantages of non-proportional reinsurance?
A
- Disadvantages of reinsurance
- Premium > expected recoveries
17
Q
- What are alternative risk transfers?
A
- Tailor made solutions for risks that the reinsurance market consider as uninsurable (market and credit risk)
18
Q
- What are the types of alternative risk?
A
- Integrated risk cover – risks are aggregated and covered like aggregate XL, it is written as a multi-year, multi—line cover
- Securitization (catastrophe bonds) – turns risk into financial security through transferring insurance risk to the banking system and it may use a SPV
- Post loss funding – arranging access to capital to cover the losses from a risk after the risk event has happened
- Insurance derivatives – OTC or exchange traded tailored derivatives used to hedge longevity and investment risks
- Swaps – swapping negatively correlated risks so that each organization has greater risk diversification
19
Q
- What are the advantages of integrated risk cover?
A
- Avoid buying excessive cover
- Saves on costs as there wouldn’t be negotiations each year as integrated risk cover is multi-year
- Greater stability of results in long term – due to diversification by type of risk insured and time
- Lock into attractive terms
- Substitute for debt or equity
- The aggregated risks reduce the need for capital (multi-line)
20
Q
- What are the disadvantages of integrated risk cover?
A
- Credit risk
- Lack of availability (this type of cover may not always be available)
- There are expenses associated with tailor made covers
- It is difficult to aggregate (multi-line) the different risk types as these would have separate risk managers
21
Q
- What are the advantages of securitisation (catastrophe bond)?
A
- Using SPV breaks direct link between the investor and issuer
- Investors experience diversification as insurance risk and financial risk are uncorrelated
- Due to uncorrelation of risks, investors may seek these securities at a lower return
- The insurer does not experience credit risk as they have received the premium for the bond at outset
22
Q
- What are the disadvantages of securitisation (catastrophe bond)?
A
- There is a risk that the return may need to be high on order to be attractive to investors
- Investors may be more concerned about information asymmetries as the insurer knows more about the lived that the bond is held against
- Market capacity is unknown and unstable
- Different administration burdens: reinsurance s easy to get into but becomes an admin burden later on while bonds are an admin issue at issue but are not later on
- Reinsurers give access to expertise and data
- Bond issue will only cover existing blocks of business and new business will not be covered
23
Q
- What are the advantages of post loss funding?
A
- Helps secure the terms in advance which avoids the pressure of raising capital during a crisis after risk event occurs
- Improves liquidity without holding cash
- Avoids opportunity cost of holding large reserves
- Allows for tailoring since the company structures the funding
24
Q
- Why would providers take out ART contracts?
A
- Provisions of cover that might otherwise be unavailable
- Stabilisation of results – reducing claims volatility
- Cheaper cover
- Tax advantages
- Greater security of payments – lower credit risk
- Management of solvency margins (reduce capital requirements)
- More effective provisions of risk management
- As a source of capital
25
25. What is coinsurance?
Coinsurance – two or more insurers who are partners and enter into a contract with an individual and in the policy it involves the 2 insurers and it is clear which insurer takes on which risk
